P OSITIONING FOR R ESET Macro Clinic Video Blog: Road Warrior of Agriculture: Ag Globe Trotter: Dave’s GPS & Dashboard Indicators: Dr. David M. Kohl Professor Emeritus, Agricultural and Applied Economics Virginia Tech, Blacksburg, VA (540) (Alicia Morris) | (540) (Angela Meadows) | January 5-6, 2016

Five Macro Factors Impacting Agriculture: Rural America’s Bottom Line  emerging nations  economic slowdown  biofuels, oil, & technology  central banking strategy  U.S. & abroad  king dollar & duration  mother nature  weather- U.S. & globally 2

2016 – 2020 Economic Reset 1  BRICS & KIMT’s – 53% world economic growth  growth moderating Rule  China does matter to fly over states  2007 to 2012 aberration in commodity prices  one half of emerging nations in recession 3

World Economic Outlook: Real GDP Growth  emerging market and developing economies  world  advanced economies Source: IMF World Economic Outlook (October 2015)

2016 – 2020 Economic Reset 2  ethanol & biofuels  oil black gold “recession effect”  deflation in commodities  regulatory issues in developed countries  political dysfunction  technology, automation  demographics 5

2016 – 2020 Economic Reset 3  40% of commodity prices & asset values  U.S. Central Bank reducing stimulus  European Central Bank increasing stimulus  60 billion plus 21 months  Japan’s stimulus  China’s Central Bank stimulus  stock market appreciation  beneficial to fly over states/Canada/Australia, etc. 6

2016 – 2020 Economic Reset 4  weather wild card  political military sanctions  quality & standards risk  consumers & public  “Black Swans” 7

Global Economics: Europe  France economy sluggish  Germany- export driven  Europe China connection  Greece  central bank stimulus extended  Ukraine 8

Global Economics: China  China PMI <50  exports down >10%  lowered rates five times  stock market up 105%, down 30 to 40%  devalued currency  natural resource issues  shadow banking 9

Global Economics: Other  Russia  oil  Mr. Putin  Brazil  recession  Infrastructure  Argentina  tax  political dysfunction  Brazil & China connection 10

Global Economics: Japan/Asia  debt issues  demographic wedge  South Korea sluggish  India quite strong 11

U.S. Economy Watch  LEI declining  PMI slowing  manufacturing, building inventory  housing 1.2 million  business cycle expansion later innings 12

Federal Reserve’s Interest Rate Barometer IndicatorPossible ChangeDefinite ChangeCurrent Status Unemployment7.0%6.5%5.0% GDP Growth2.0%2.5%2.1% Core Inflation2.0%2.5%1.9% Headline Inflation4.0%5.0%0.2% 13 Watch List: Dr. Yellen FOMC voting FOMC minutes Rail traffic Shoe shiners Copper prices Overland trucking Baltic Sea index

Grain Industry- Reset  easy money has been made  top notch managers adjust  high overhead/fixed cost structure  classic tail effect  prices go down  costs lag  cycle duration 14

Grain Producers: “Houston, We Have a Problem ” Super Cycle ObservationConstant 2014 Dollars Median Net Income $169, $66,574 Super Cycle2.42 x’s greater $32, $40,123 Lost 40% working capital in two years Greater 60% Debt to Asset Ratios under 10% working capital Operators under age of to 15% working capital Most leveraged farms- negative working capital Debt coverage ratio is 45% 15

Livestock Industry  strategic resource shift  grain industry economic Vortex  50 to 65 year olds will not return  1953/73/78  cycle duration  curve ball effect 16

Roller Coaster Economics Reset  2007 to 2012 aberration for the grain industry  dot com bubble of agriculture  asset bubble vs. credit bubble  livestock: Clayton Kersaw’s curve ball effect:  hogs  beef  dairy  poultry  asset “fixed cost” operating cost adjustment  early innings of adjustment 17

Nine Innings of an Evolution of a Cycle Reset 1.profits start to decline but asset appreciation continues 2.new lenders enter the market place 3.strong equity growth mentality creates complacency 4.machinery & equipment values first to decline 5.aggressive growth businesses & fraudulent activities occur 6.margin negative cash flow & operating lines of credit become an issue 7.marginal assets discounted 8.non-traditional & new lenders retreat 9.quality assets adjust in value depending upon length of adjustment 18

Positioning for the Reset  family living cost- business & personal  machinery & equipment investment  crop cost $100 to $150 per acre “15% to 30%”  reduction of human assets “uncle example”  earns & turns – “margin/capital turnover” 19

Business Equation for Success P=O+C+L+M²  P=people, profits, & plans  O=overhead cost control  C=costs- know thy cost  L=liquidity-cash is king  M²=marketing & management = margin 20

Screening Guide for Negative Margins 1 Historically has the producer/entity:YesNo Been profitable above interest rates and rate of inflation? Shown growth of balance sheet which is earned vs. appreciated net worth? Has built and protected working capital in positive cycle? Been able to cut living expenses if needed? Been able to sell unproductive assets? Followed and executed a marketing risk management program? Have the ability to cut 10 to 30% of costs? 21 Producer Version

Screening Guide for Negative Margins 2 Historically has the producer/entity:YesNo Been able to shed unprofitable land, machinery, livestock, & human assets if necessary? Had a burn rate for working capital 2.5 years or more? Had a term debt/EBITDA ratio <5 to 1? 22 Scoring Key: >8 Yes boxes checked= strong case for sustainability 5-8 Yes boxes checked= modest case for sustainability <5Yes boxes checked= very questionable for sustainability Producer Version

The Burn Rate – Working Capital Revenue $2,000,000Current Assets $1,000,000 Expenses 2,200,000 Current Liabilities 500,000 Loss $200,000 Net Working Capital $500,000 Net Working Capital $500,000= 2.5 Years Projected Loss $200,000 Green >3.0 Years Yellow Years Red <1.0 Year 23

The Burn Rate – Debt Service Payments Revenue $2,000,000Current Assets $1,000,000 Expenses 1,800,000 Current Liabilities 500,000 Profit $200,000 Net Working Capital $500,000 Debt Service Payments = $100,000 Net Working Capital $500,000= 5.0 Years Debt Service Payments $100,000 Green >5.0 Years Yellow Years Red <2.5 Years 24

Financial Dashboard Key RatioGreenYellowRed Coverage Ratio>200%125% to 200%<125% Working Capital/Revenue>33%10% to 33%<10% Equity Percent>70%40% to 70%<40% Term Debt/EBITDA<350%350% to 600%>600% ROA- Return on Assets>6%2% to 6%<1% 25

Financial Characteristics that Thrive During Tough Times Characteristic:YesNo Working capital revenue above 33% Burn rate working capital to net income loss over 2.5 years Burn rate of working capital to annual debt service payments 3.0 years or greater Moderation in family living costs Debt coverage ratio above 125% 26

The Five “P” Evaluation of Successful Business Planners(1) Evaluation Points:Rating Paradigm: Conversations center around profitability instead of production, operations Receptive to new technology & ideas High priority on education & training for new ideas View people inside & outside of business as important resources People: Employees & suppliers trust & respect them Employees & management are given opportunity to grow Employees & suppliers enjoy working with this business Low employee & management turnover Planner: Utilize a business mission statement & core values Use tactical plans to achieve written business goals Use record systems (financial, production) to monitor & evaluate performance Could leave their business for a week/month & things would run smoothly 27 Rate the following statements regarding business planners. 1-Strongly Disagree, 2- Disagree, 3-Neither Agree or Disagree, 4-Agree, 5- Strongly Agree _____ _____ _____ _____

The Five “P” Evaluation of Successful Business Planners(2) Evaluation Points:Rating Problem Solver: Identify problems in the business before they are obvious Seldom have the same problem reoccur in their business Solicit input from ag & non-ag sources when looking for solutions Take responsibility for their decisions Proactive: Can make a decision & accept consequences Productive & gets things done Complete tasks - multitaskers Complete tasks on schedule Scoring: Total Score High Potential for Success Above Average Potential for Success Needs Management Assistance for Success <70 Probably will be around until the money runs out 28 Rate the following statements regarding business planners. 1-Strongly Disagree, 2- Disagree, 3-Neither Agree or Disagree, 4-Agree, 5- Strongly Agree __________ _____ _____ _____ Source: Adapted & Revised from Southeastern Agricultural Lenders School

Problems You Want Your Business to Have (1)  You pay income taxes.  You can leave your business for a month & the business runs smoothly.  Your lender seeks you for business.  People want to work for your business.  Your business has idle cash and liquid financial assets.  You can fire your customers/suppliers.  You leave money on the table in some deals. 29

Problems You Want Your Business to Have (2)  You surround yourself with people smarter than you.  You spend time networking and seeking education.  You could send your son/daughter/assistant away for two years.  You appear to be dissatisfied, not happy with status quo.  You occasionally fail. 30

Ten Best Management Practices of Young Producers  modesty in family living  invest in productive assets  personal/business  independent vs. interdependent  lifelong learners  strong group of peers  good set of mentors  profit plan  get better before getting bigger  balance between head/heart (numbers vs. passion)  strong relationship with lender 31